After your manufacturing company's 2022 tax return has been filed, you can focus your efforts on reducing its 2023 tax liability. What are the top tax-saving opportunities available to manufacturers this year? Here are seven prime candidates available for many companies:
- Section 179 deduction. The Sec. 179 "expensing" deduction continues to be a mainstay for manufacturers. Under the deduction, a manufacturer can expense, or currently deduct, the cost of qualified new or used business property placed in service during the year, up to an annual inflation-adjusted limit.
Qualified property includes business property with a cost recovery period of 20 years or less. For 2023, the limit is $1.16 million (up from $1.08 million for 2022).
However, the deduction can't exceed the amount of business income for the year. Furthermore, the deduction is phased out dollar-for-dollar for amounts above an annual threshold. The threshold for 2023 is $2.89 million (up from $2.7 million for 2022).
- First-year bonus depreciation. If the Sec. 179 deduction doesn't cover all business property acquired in 2023, first-year bonus depreciation can be a valuable supplement. For 2023, the Tax Cuts and Jobs Act (TCJA) authorizes an 80% first-year bonus depreciation (down from 100% for 2022) for qualified property placed in service during the year. The property can be new or used. The percentage will drop to 60% for 2024 and another 20 percentage points per year through 2026. After 2026, no bonus depreciation will be allowed unless Congress revisits this issue. Accordingly, a manufacturer may want to accelerate property acquisitions into 2023 to take maximum advantage of the bonus depreciation deduction. Keep in mind that, for you to claim the deduction, the property also must be placed in service during the tax year.
Bonus depreciation generally is applied after the Sec. 179 deduction is claimed. If any amount remains, it's subject to the regular cost recovery rules.
- Research credit. Often referred to as the research and development or research and experimentation credit, your manufacturing company may be eligible to claim it for qualified expenses. Generally, the credit equals 20% of qualified research expenses for the year over a base amount.
For these purposes, the base amount is a fixed-base percentage (not to exceed 16%) of average annual receipts for the prior four years. It can't be less than 50% of the annual qualified research expenses. Alternatively, a company can use a simplified 14% credit.
- Retirement plans. The SECURE 2.0 Act, enacted at the tail end of 2022, makes sweeping changes for retirement accounts, with varying effective dates. For instance, the law:
- Increases the age to begin taking required minimum distributions (RMDs) to 73 beginning January 1, 2023, and boosts it to 75 on January 1, 2033,
- Eases the penalties for failing to take full RMDs, reducing the 50% excise (or penalty) tax to 25%,
- Increases the annual limit for catch-up contributions,
- Requires 401(k) plan catch-up contributions to be made to Roth accounts,
- Provides for automatic enrollment in new plans, except for certain small companies,
- Expands the eligibility for part-time workers,
- Creates emergency savings accounts linked to retirement plans,
- Allows penalty-free withdrawals for certain emergencies,
- Enhances the tax credit for starting up a retirement plan, and
- Replaces the retirement saver's credit with a matching government contribution.
Again, the effective dates for these provisions vary. Contact SSB for more details.
- Qualified business income deduction. A manufacturer operating as a pass-through entity—such as a partnership, S corporation or limited liability company—or as a sole proprietorship can benefit from the qualified business income (QBI) deduction.
The maximum deduction is equal to 20% of QBI (essentially, your net profit from the business). Notably, the QBI deduction is subject to a phase-out, based on your income. For 2023, the threshold is $182,100 for single filers and $364,200 for joint filers, up from $170,050 and $341,000, respectively, for 2022.
- Form of business ownership. Depending on several variables, a switch in your company's form of business entity may be warranted. For instance:
- A C corporation can change to S corporation status to avoid double taxation and benefit from the QBI deduction (see above).
- A sole proprietor can use a pass-through entity to save on self-employment tax.
- An S corporation may revoke its status so that it can pay tax at the lower C corporation rate of 21%.
Note that changing your business' entity may be treated as a taxable event.
- Accounting methods. Manufacturers can save tax through astute choices relating to accounting methods. For example, it may make sense for your company to switch to the last in, first out (LIFO) method of accounting for inventory. Switching to LIFO can be beneficial when costs are rising due to inflation. LIFO may result in bigger deductions for the company as inventory prices increase.
Similarly, under the TCJA, your company may use the simplified cash method of accounting if receipts don't exceed $25 million, indexed for inflation, for the past three tax years. The threshold is $29 million for the three years ending prior to 2023. This method may provide greater flexibility at the end of the year.
These are just seven tax-saving opportunities available to manufacturers in 2023. Contact your SSB advisor to discuss which strategies are right for your company.